Rise Of Corp Governance & Shareholder Activism In India

While corporate governance has acquired prominence in India for nearly two decades now, it has taken centre-stage more recently due to wide-ranging reforms. The new Companies Act, 2013 has ushered in significant changes in the way companies are to be managed and governed. Consistent with this approach, the Securities and Exchange Board of India (SEBI) has also announced changes to its corporate governance regime to bring it in tune with the new Companies Act. Governance issues have received impetus through market developments as well. Shareholders (particularly of the institutional variety) have begun to take on a more activist role in companies, and they are aided by a burgeoning proxy advisory industry that has established deep roots in India within a short span of time. A discussion on developments in corporate governance and shareholder activism in India could not have been timelier. At the same time, these developments ought to be considered in the context of global developments in corporate governance.

The discussion on governance reforms may be bifurcated into issues pertaining to the board of directors and those pertaining to the shareholders (where the phenomenon of shareholder activism occupies pride of place). Beginning with the board of directors, the spotlight in India has, among other things, been focused squarely on independent directors. The Companies Act, 2013 adopts a “regulation-heavy” approach towards board independence. It is considerably prescriptive regarding the number of independent directors, their appointment, their role, their duties and their liabilities. While the legislation addresses several pressing concerns regarding board independence, it is not clear if its implementation will be without difficulties. Corporate governance norms are dynamic in nature and require periodic reconfiguration to keep pace with the ever-changing business environment. Usually, while the basic governance framework is dealt with by statures, the details are dealt with in codes of conduct that are more flexible in nature. The question remains whether an attempt to address governance norms through legislation might lead to unnecessary rigidity in compliance and enforcement.

Internationally too, issues of board composition and compensation have occupied the minds of regulators. While board independence has become accepted practice, differences about as to the extent to which it is required and to be relied upon. The issue of compensation of directors, including independent directors, has become prominent following the global financial crisis, and the effort is still ongoing to arrive at the right balance that provides sufficient incentive to attract the right talent without creating any distortions that might adversely affect the interests of the company or its shareholders. While issues of board independence and director compensation are not new, they are likely to continue to be at the forefront of corporate governance debate in the years to come.

Moving to shareholders as a constituency, activism on their part, a hitherto non-existent phenomenon in India, has become pervasive in recent years. This development has been aided both by efforts on the part of the regulators to encourage shareholder participation in corporate decision-making, and by growth in the activist stance of institutional investors in the Indian markets. This is part of a growing international trend, particularly in the wake of the global financial crisis.

Over the last decade, regulatory reforms have focused on promoting shareholder participation in corporate decision-making. This has been implemented through legislative and regulatory measures. While the Securities and Exchange Board of India (SEBI) initiated measures in 2012 to introduce electronic voting, the new Companies Act, 2013 provides for electronic meetings, minority shareholder rights to approve significant related party transactions and other forms of protection to minority shareholders such as the class action mechanism. These measures are expected to engender greater participation by shareholders in general meetings of companies.

Apart from regulatory measures, shareholders themselves have been proactively adopting an activist stance. They have begun to engage with management and promoters of companies to pursue corporate policies that may enhance shareholder value. Where mere interaction with management is found to be ineffective, activist investors typically advance to the next stage of voting against the company’s resolutions. The ultimate option of confronting management with efforts to displace them has been used elsewhere in the world, but in India such option is quite daunting given that most companies are controlled through a significant stake held by the promoter.

The activist investors are now effectively aided by the emergence of a set of corporate governance intermediaries in the form of proxy advisors. While proxy advisors play a significant role in influencing corporate decision-making internationally, the industry is still nascent in India (although it is gradually exerting its presence as a key corporate governance intermediary to reckon with).

These developments have brought about a paradigm shift in corporate governance. Anecdotal evidence suggests that managements can no longer take shareholders for granted when seeking their approval of significant corporate transactions. These may have the effect of raising transparency and governance standards in Indian companies, particularly where they are listed on a stock exchange.

This is consistent with the trend elsewhere. World over, shareholder activism has taken on a more vibrant role, particularly after the global financial crisis. While institutional investors have been gradually increasing engagement with their portfolio companies, the new brand of hedge fund activism has taken corporate boardrooms by storm. Influencing their actions are proxy advisory firms such as ISS and Glass Lewis, which are two predominant firms in the industry.

In all, these developments (particularly in relation to shareholder activism) have brought about a significant change in the way companies are managed. No longer can managements pay short shrift to governance concerns, as their actions (and omissions) will to put to strict scrutiny from the perspective of their effect on minority shareholders as well as other stakeholders.

Professor Umakanth Varottil and Sergio Sánchez Solé, Garrigues are co-chairing a session on the Rise of corporate governance and shareholder activism in India at the IBA M&A Conference in Mumbai, 21-22 March 2014